Morningstar | Xerox Struggles With Profitability in Strategic Transformation; Maintaining Our $32 FVE
Xerox suffered from worse than expected profitability in the second quarter and a slight decrease on the top-line. Cash generation was one of few positive points along with success in Managed Document Services. Having factored in unfavorable secular forces ahead as management looks to reinforce a new business optimization plan, along with encouragement in growth from Xerox’s SMB customers, we are maintaining our fair value estimate of $32 for the no-moat company.In Xerox’s second quarter, profitability was lower than expected, with adjusted operating margins down year over year by 130 basis points at 11.9%, while gross margins were down by 7 basis points at 39.9%. For the latter, the culprit was less premium products in the sales mix.
Sales were down by 2.2% year over year at $2.51 billion. Overall equipment sales were up by 0.9% year over year, with growth coming from entry and mid-range products.
The biggest geographical decline came in Other, which was hit by Xerox's OEM business--like last quarter--this time leading to a 29% year-over-year decline. The region makes up only 4% of Xerox's sales, but the OEM business has continued to struggle because of concentrated customers. North America and international saw less drastic change, with North America sales down by 1.3% and international sales up by 0.3% year over year.
As for products and services, managed document services grew 2.3% because of increased equipment sales and growth in Partner Print Services, which focuses on SMBs. The product comprises 35% of total revenue and has shown consistent growth over the last few quarters. Therefore, we’re relying on managed document services to help Xerox stay on track on the top-line as it tackles profitability and its current 75% renewal rate.
Xerox continues to hold back on giving near-term guidance. However, management stressed its commitment to cash flow generation and plans to repurchase up to $500 million in shares in 2018. While Xerox states that it is not partaking in an auction for the business given its associated costs, it made it clear that it would assess any deals offered if buyers come to them; though management steered clear of commenting on a Fuji-Xerox deal.
Xerox is a provider of digital print technology and intelligent work solutions. The company operates in three main areas: Intelligent Workplace Services, which includes a continuum of solutions and services consisting of managed print services, industry digital solutions, personalization and communication software, content management solutions, and digitization services; Workplace Solutions, which is made up of two product groups, Entry and Mid-Range, which share common technology, manufacturing and product platforms; and Production Solutions, which enable full-color, on-demand printing of a range of applications, including variable data for personalized content and one-to-one marketing.
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